The first cost any mutual investor faces is a fund’s minimum. Some funds have no or low minimum investments, but many have sizable ones. In an article for Financial Planning published August 1, Brigham Young University professor Craig L. Israelsen finds that a higher minimum does not at all imply a better performance.
That may not be great news for people who thought they were buying a Rolls Royce when they plunked down tens of thousands to get into some funds. Turns out they had bought the same Honda as everyone else. For investors with more modest investment budgets, it’s good news. “To put it bluntly , the price of admission to a fund (that is, the size of the initial investment requirement) has virtually no connection to the skill of the portfolio manager or the likely performance of the fund. In the case of mutual funds, paying more doesn’t get you more.”
In this study, Israelsen, who also is the creator of a series of investment portfolios and author of the forthcoming book 7Twelve: A Diversified Investment Portfolio with a Plan, and Brigham Young student Nicole Lindsley, sorted through the Morningstar database by minimum required investment. Most funds, over 51%, required a minimum purchase between $1,001 and $2,500. 21.5% had minimums of $1,000 or less, 27% wanted more than $2,500 with a small number requiring millions to buy in. The authors divided the funds into eight different styles for comparison: U.S. large-cap value, large-cap blend, large-cap growth, small-cap blend, small-cap growth, U.S. large-cap blend, emerging markets and domestic intermediate bond.
Of the eight categories, six revealed no performance advantage among funds with high initial investment requirements. As the authors note:
In general, mutual funds that have high pay-to-play requirements don’t back it up with better performance. An investor buying a mutual fund with a low initial investment requirement is-in most cases-not being penalized with lower returns. Even when the funds [with the highest minimum s] demonstrate better performance than [those with the lowest]the performance differential is modest.
When they examined the “large-value” funds, the authors found 96 funds total. The 24 with the lowest minimums (averaging just $15) had a five-year performance from 2005 to of -0.6%. The 24 platinum priced funds, with an average initial investment of $1.68 million, did a bit better, with a 0.4% average performance during the same five year block. That difference “practically speaking” the authors write “is quite small.”
In some cases the high admission funds did not outperform, even within fund families. The TIAA-CREF Large-Cap Value Retirement fund (TRLCX), with a minimum initial investment of zero, and the TIAA-CREF Large-Cap Value Index Institutional fund (TILVX), which has a $10,000,000 minimum initial investment, had almost identical returns. TRLCX was -0.2% for that five years, compared with -0.3% f or TILVX.
The cash needed to fund a three-asset class portfolio of Homestead funds (U.S. equity , non-U.S. equity and a bond fund) is $1,500. Or, you could drop $725 million into three GMO funds that cover the same three asset classes. In each case, the Homestead fund had a better five-year record as of May 31, 2010.
The GMO funds have lower expense ratios, but those are already accounted f or in the returns, the authors note. GMO did not reply to our requests for comment on the study’s findings. But TIAA-CREF spokesman Chad Peterson did note that fund account minimums and expense structures are designed for different types of shareholders, and that the Institutional share class is aimed at retirement plans and high net worth individuals. The Retirement share class also is generally not sold directly to individuals, but through employer sponsored plans. And there is a rationale for the minimums, Peterson writes, which “are designed to ensure the ability to take advantage of economies of scale and to keep expense ratios lower.”